Stock markets all over the world have a number of “Indices” for your stocks that define each market. Each Index represents a specific industry segment, or broad market itself. Most of the time, these indices are tradable instruments themselves, and also this feature is called “Index Trading”. An Index represents an aggregate picture in the companies (often known as “components” with the Index) that make up the Index.
For instance, the S&P 500 Index can be a broad market Index in the usa. The ingredients of the Index are the 500 largest companies inside the U.S. by Market Capitalization (also called “Large Cap”). The S&P 500 Index can be another tradable instrument in the Futures & Options markets, and yes it trades underneath the symbols SPX inside the Options market, and under the symbol /ES in the Futures markets. Institutional investors in addition to individual investors and traders manage to trade the SPX and the /ES. The SPX is simply tradable during regular market trading hours, but the /ES is tradable almost Around the clock in the Futures markets.
There are numerous explanations why Index trading is quite popular. Since SPX or the /ES represents a microcosm with the entire S&P 500 index of companies, an angel investor instantly gets contact with your entire basket of stocks that represent the Index after they buy 1 Option or Future contract with the SPX along with the /ES contracts respectively. This means instant diversification for the largest companies from the U.S. built into the convenience of 1 security. Investors constantly seek portfolio diversification to prevent the volatility related to holding just a few company stocks. Buying an Index contract provides an good way to achieve this diversification.
Another point to consider for that availability of Index trading is a result of how the Index is itself designed. Every company in the Index carries a certain relationship together with the Index when it comes to price movement. For instance, we could often observe that when the Index rises or falls, a lot of the component stocks also rise or fall very similarly. Certain stocks may rise over the Index and certain stocks may fall more than the Index for similar moves within the Index. This relationship between a stock and its parent Index may be the “Beta” from the stock. By taking a look at past price relationships from the Stock and Index, the Beta for each stock is calculated and it is on all trading platforms. This then allows an angel investor to hedge a portfolio of stocks against losses by buying or selling a specific number of contracts from the SPX or /ES instruments. Trading platforms have become sophisticated enough to instantly “Beta Weigh” your portfolio for the SPX and /ES. It is a major advantage every time a broad market crash is imminent or perhaps underway already.
Another advantage of Index trading is that it allows investors to adopt a “macro view” from the markets of their trading and investment approaches. They will no longer worry about how individual companies in the S&P 500 Index perform. Regardless of whether a really large company would face adversity of their businesses, the outcome this provider might have around the broad market Index is dampened because other businesses could be succeeding. That is exactly the effect that diversification is supposed to produce. Investors can tailor their approaches based on broad market factors as opposed to individual company nuances, which could become very cumbersome to follow.
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